Has OPEC Been Too Successful?

Last week, OPEC said in its Monthly Oil Market Report that based on OECD commercial stocks numbers from December, “In line with the existing overhang, the market is only expected to return to balance towards the end of this year.”

But the latest discussions within OPEC’s Joint Technical Committee have concluded that the stock overhang is being depleted at a faster clip than previously thought, suggesting that the market will be in balance as early as the second or third quarter of 2018, Bloomberg reports, citing people familiar with the discussions.

The fast drawdown of the stocks in developed nations is now posing two new dilemmas for OPEC, on top of the U.S. shale dilemma: should it consider exiting earlier than it had originally planned? And would an early exit bring down prices below comfortable levels? Alternatively, should it try to measure stocks in non-OECD nations including in Saudi Arabia, China, India, and Russia? Or should OPEC and Russia move the goal posts and accept another metric for a broader market view instead of the five-year average of commercial crude oil and oil product stocks in industrialized OECD nations?

The thought that the drawdown is nearly upon us is largely in line with the opinions of some big investment banks, who last month suggested that OPEC and the non-OPEC producer group led by Russia may decide to wind down their production cuts starting mid-year based on the dwindling overhang — instead of sticking it out through end-2018 as planned.

Both Citigroup and Goldman Sachs, for example, see the current oil market as already balanced for the most part. Other analysts expect balance to be achieved in the second or third quarter.

Over the past week, the International Energy Agency (IEA) also reported a quickening pace of OECD commercial stock drawdowns, saying that the OECD stocks are now just 52 million barrels over the five-year average, and oil products stocks are actually below the benchmark. “With the surplus having shrunk so dramatically, the success of the output agreement might be close to hand,” the IEA said.

Then this week, at a Nigerian oil industry summit, OPEC Secretary General Mohammad Barkindo said that OECD commercial oil stocks were 74 million barrels above the latest five-year average, a drawdown by more than 265 million barrels since January 2017.

Almost everyone is in agreement that the market is expected to be in balance before the OPEC/NOPEC deal is expected to end.

The drawdown is due in part to OPEC/NOPEC’s successful adherence to the cuts. Last month’s compliance rate with the cuts was 133 percent, Barkindo said, praising the OPEC/non-OPEC partnership with which “the market rebalancing process has gained massive momentum.”

The most influential OPEC minister, Saudi Arabia’s Energy Minister Khalid al-Falih, has nevertheless sent a message to the market that the Saudis are firmly holding on the production cuts by the end of the year, and they would rather risk overtightening the market than not fully achieving the goal.

“If we have to err on over-balancing the market a little bit, so be it,” al-Falih said.

The Saudi minister also said that OPEC would discuss in April and in June how exactly to measure the global oil stocks, because the center of demand has shifted from OECD to non-OECD countries. Currently, OPEC’s officially announced target with the production cuts is to bring back oil stocks in industrialized OECD nations back to their five-year average.

This average, however, is higher this year compared to last year because it includes more years in which stocks were in oversupply.

Still, data from non-OECD countries is often patchy and not transparent.

“Do we need to adjust for rising demand and look at forward day cover? How do we deal with non-OECD inventory? [It’s] less transparent and reliable,” al-Falih said.

While OPEC and friends have managed to nearly erase the oil glut, they now face another tough discussion: when and how to start exiting the cuts. The cartel’s de facto leader and largest producer Saudi Arabia is said to be targeting oil prices at $70, so advocating for continued commitment throughout 2018 — even if the market overtightens — is not surprising.

The official comments from both Saudi Arabia and Russia are that it’s too early for an exit strategy, except the common-sense assumption that the exit should be gradual to avoid an oil price slump.

Instead of an exit strategy, OPEC is feeding the market with talk about institutionalizing the cooperation into a kind of permanent partnership of the ‘super group’ of oil-producing countries.